Investing in commercial real estate: Pros and cons, tax implications explained

Real estate investment decisions are typically difficult, particularly when deciding between residential and commercial property. It is widely assumed that investing in commercial real estate is only for wealthy individuals and corporations. Although this is sometimes true, it is not always the case, and commercial property, particularly shops and showrooms, can be purchased by salaried individuals.

Because of its consistent returns, higher rental value, and passive income, commercial real estate is an appealing investment class. It has enormous growth potential and a consistent cash flow in the form of rentals. This is why commercial real estate investing is becoming increasingly popular among investors. Let us evaluate the pros and cons of purchasing commercial property.

Pros of investing in commercial real estate properties 

• High rental income

Commercial property has a higher rental yield than residential property, which is advantageous. Commercial properties have an average rental yield of 8-11%, whereas residential properties have an average rental yield of 1-2%, a 4 times lower yield. The earning potential for CRE investment varies greatly depending on the area. If the investment is made solely for the purpose of earning potential through rents, commercial property is unquestionably superior.

• No furnishing cost

One of the most appealing aspects of investing in commercial properties is the property's zero furnishing cost. This is because the furnishing costs are borne by the tenant once the property is rented. As an investor, you can provide your tenant with raw property. This benefit stems from the fact that any company renting the property will be required to adhere to their operational guidelines.

• Ease in dealing with tenants

Commercial real estate tenants are typically well-established companies. Dealing with corporate tenants is always easy, and there is rarely a need to chase them down for rent. If a reputable bank or corporate tenant occupies one floor or one section of the property, the rental yield for the remainder of the property will rise.

• Long-term commitments

Commercial properties are typically leased for 10 to 20 years, with the option of renewal. Furthermore, lease agreements include a provision for yearly rental value appreciation. As a result, the commercial property owner can expect regular and consistent returns.

Cons of investing in commercial real estate

• High investment

In general, commercial properties necessitate a significant investment. In the case of commercial property, a larger sum is involved than in the case of residential property. After considering one's other financial needs and commitments, one must be prepared to invest a large sum. and the minimum investment in commercial real investment is typically out of reach for the average retail investor.

• Costlier loans

Commercial property loans are more expensive than residential property loans, which is a significant disadvantage of commercial property. The interest rate and terms and conditions will also be determined by the type of property, the investor's profile, the location, and the repayment period.

• Complex asset management

Finding the right tenant for commercial property like a shop or showroom may be slightly difficult than finding a tenant for a residential property. CRE tenants are corporates, not individuals, requiring smooth end-to-end asset management. Retail investors usually lack professional expertise in managing complex commercial assets. 

• Thorough research required

The investor must conduct extensive research into the overall cost of acquiring the property, the taxes involved, the zonal laws and bylaws for renting out, and the rental earning potential of that building or shop. Due diligence and market knowledge are required to find the right property and geographical location. Due to a lack of market knowledge and other resources, an individual investor may find it extremely difficult to invest in commercial properties.

Tax implications 

Commercial property investment through fractional ownership is still in its early stages, so there are no specific regulations for this asset class. According to current income tax regulations, if you do not own the property and sublet it, the income from such subletting of commercial property will be taxed under the heading 'income from other sources.'

If you run a business centre on your property while also providing other services, the income can be treated as business income as long as the different services and renting out the space account for a significant portion of the total. Except in these circumstances, all of the income you get related to the property you own will be taxed under the head explicitly designated for property income, regardless of the name given to the revenue. There are just a few legal deductions that can be made against rental income because the revenue from renting out such property is taxed under the heading "income from house property." It is best to avoid listing your actual rental income under "earnings and gains of business or profession" in order to deduct other costs.

Authored by Anurag Goel, Director, Goel Ganga Developments